Push to tax income of the top 1% is stronger than ever — and no less risky

Governments acting like Robin Hood, however, have tended to provoke unforeseen problems, most recently in Britain, where an effort to tax the rich ended up — quite literally — costing the government deeply.

In 2008, on the campaign trail amid a global financial collapse, Barack Obama’s stated desire to “spread the wealth around” clanged like a dropped wrench and made a media star of Joe the Plumber.

This week, in a stalled recovery, that very same sentiment made for one of his more rousing campaign lines, shamelessly tailor-made for an economic ballot question against the arch-capitalist Republican Mitt Romney.

In calling for a hike in income tax to 30% on those who make more than $1-million a year, Mr. Obama told Florida university students this week that, in America, “prosperity has never trickled down from the wealthy few. Prosperity has always come from the bottom up.”

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That the rich should contribute more than their current share to the common good is a proposal with popularity. From Paris and London to Nova Scotia and Alberta, “tax the rich” has become a dominant theme in budget debates and elections around the world.

In Ontario, for example, NDP leader Andrea Horwath’s proposal to create a new tax bracket for people who make more than half-a-million dollars a year, illustrates the persistent attraction of such schemes for governments in deficit.

“The issue really is one of perceived fairness,” said Robin Boadway, a taxation expert and professor of economics at Queen’s University, who notes that the income of the highest earners has been increasing much faster than the middle and lower ranks. Taxation, to a great degree, relies on the goodwill and trust of citizens, he said, and inequality in tax codes can violate that trust.

Governments acting like Robin Hood, however, have tended to provoke unforeseen problems, most recently in Britain, where an effort to tax the rich ended up — quite literally — costing the government deeply.

Known in France as Fouquet’s Tax (after the posh restaurant on the Champs-Elysées where President Nicolas Sarkozy celebrated his election win in 2007) and in America as the [Warren] Buffett Rule (after the billionaire’s famous observation that his secretary is taxed at a higher rate than he is) the political push to overcome deficits by raising taxes on the richest 1% is stronger than ever, and no less risky.

Under a seemingly irrefutable slogan that cleverly obscures the fact that the rich already pay tax (usually a great deal), the desire to squeeze even more out of society’s top earners follows on the Occupy Movement’s success in tapping popular resentment of financial elites whose flagrant risk-taking caused the 2008 economic collapse. Once a revolutionary war cry, “tax the rich” has become mainstream coffee shop chatter.

“If we have to choose between a working mom who needs child care to keep her job, or someone earning a seven-figure paycheque, let’s help that mom,” Ms. Horwath said in touting her new tax bracket, a proposed amendment to the minority Liberal budget. “I don’t think it’s unreasonable to ask those who are doing the very best, the very best in Ontario, to help out a little bit more,” she said.

“One of the things that’s driving these policy changes is the huge increase in inequality at the top of the income distribution,” said Kevin Milligan, an economist at the University of British Columbia. “One thing that’s striking about that is not just the fact that the 1% is getting more, but the composition of who is in that top 1% is very different from what perceptions might be. People like to think about rich capitalists just getting dividend income or something like that … rich men in monocles top hats, the Monopoly-style caricature of the rich.”

Now, however, the majority of the top 1% — which, in Canada starts around $250,000 a year in income — are earners, he said. Their income comes from wages, not invested capital, and so instead of playboy heirs and reclusive matrons producing nothing but interest from their fortunes, today’s 1% are typically executives, pro athletes, doctors and lawyers.

As a result of this shifting nature of rich people, Prof. Milligan said, raising taxes on them is unlikely to have the NDP’s intended effect of boosting government revenue by $570-million. The rich are still different than you and me — and they have better accountants. As a result, tax-the-rich schemes have paradoxically led to declines in taxable income, as the wealthy seek shelters. Increasing tax without addressing legal methods of avoidance is likely to end in disappointment, Prof. Boadway said.

It can also be a political, and fiscal, minefield.

Last week, for example, Spain’s economy minister was slapped down by his own party for suggesting that high earners should pay for state-run health care. While in California, lawmakers have ended months of bickering over deficits by settling on a plan to raise state income taxes for seven years on people earning more than $250,000, with the top rate rising to 13.3%, the highest in the United States.

Two years ago the British government introduced the psychologically fraught top rate of 50% on top earners, boasting that it would raise a billion more pounds a year from self-reporting taxpayers. In fact it raised half-a-billion pounds less, and after knocking it back down to 45% in his new budget, Chancellor of the Exchequer George Osborne said this week he had been “shocked to see that some of the very wealthiest people in the country have organized their tax affairs, and to be fair it’s within the tax laws, so that they were regularly paying virtually no income tax.”

The Ontario NDP claims its plan to boost provincial income tax from 11.16% to 13.16% on all income over $500,000 would raise an additional $570-million a year for the province. That would bring Ontario in line with other provinces, such as Nova Scotia, New Brunswick, Saskatchewan, British Columbia and the territories, which all have special high tax rates for people whose income surpasses $100,000. The others start the highest rate at lower incomes, around $65,000. (Alberta, an outlier with the only true flat tax of 10%, saw its NDP party last week propose raising income taxes to 12% for people who earn more than $200,000, and 15% for those who earn more than $500,000.) Ontario Premier Dalton McGuinty’s praise for the NDP’s “sincere effort” suggests that, six months after the Occupy protests ran their course, their ideals continue to influence policy debates.

The danger, as Prof. Milligan describes it, is that those ideals can be naive and simplistic.

Fears of high earners fleeing the province are overblown, he said, because whereas capital is easily moved, people tend to stay where their jobs are for reasons that transcend the tax code. You would have to tax an NHL player, or a top Bay Street lawyer, a whole lot more than the Ontario NDP proposes in order to make him work less, or consider leaving the business.

But if the goal of the rich tax is to raise extra money for government (Ms. Horwath has proposed that the extra money be used to finance a tax cut on home heating) the problem of tax avoidance looms large, and the British precedent is hard to ignore.

“I don’t know if it’s really going to raise the revenue they hope it will,” said Geoff Loomer, a former tax lawyer and professor at the Schulich School of Law at Dalhousie University in Halifax. Two years ago, Nova Scotia boosted income tax on top earners over $150,000 so that their total bill, with federal tax, came to 50%, but middle-income earners still fund nearly the entire provincial income tax, Prof. Loomer said.

He doubts that anyone with an income over $500,000 is paying all of Nova Scotia’s income tax, and said he would be shocked if anyone making more than $1-million is paying tax at the highest statutory rate. If they do, he said, they have lousy tax advisors.

He also doubts the result of a poll this week by the Broadbent Institute that suggests Canadians are willing to pay more taxes to support health and education. They may want other, richer people to pay more, but young families with mortgages, for example, are unlikely to wish that on themselves. “I’d be very surprised if that’s true,” Prof. Loomer said.

For most people, offshore tax shelters and shrewd accounting are not worth the cost, effort or risk. But very rich people facing a substantial hit are likely to seek ways to avoid it, a factor not included in the Ontario NDP’s optimistic calculations.

In discussing tax hikes, economists fret over the Laffer Curve, which illustrates the hypothetical impact of changing tax rates on taxable income. First sketched on a napkin by American economist Arthur Laffer to explain a point to a journalist, it embodies the principle that higher tax rates can mean lower tax revenue, and that there is a hypothetical sweet spot for any country’s tax scheme. Tax too low, and you miss out on potential revenue. But tax too high, and you not only risk hindering growth, but people find ways around it. In both ways, the government ends up with less.

Rough calculations, with wide margins of error, suggest that the highest possible effective tax rate in Canada could be in the mid-60s, compared with something in the 70s for the U.S., and in the 50s for the U.K., said Prof. Loomer.

So there may, theoretically, be room to increase taxation at the top, but the law of unintended consequences can sometimes trump even the most aggressively egalitarian tax code.

“There’s this idea that there’s a pot of gold that we can go grab and it’s not going to do anything else, that it’s going to fulfill all of our dreams,” Prof. Milligan said. “I think we need to have a lot more realistic assumptions on the revenue side.”

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